- There is no objective or commonly accepted definition of a "blue-chip REIT".
- You won’t find it in Merriam-Webster’s Dictionary no matter how hard you look, though I think the explanation I’ve compiled here should suffice.
- After screening for the highest quality REITs, I'll provide you with a list of three worth buying.
Blue chip companies are defined as large, well-known firms with a history of earnings and dividend growth and that offer quality management.
One of the reasons that are I own many of these so-called blue-chips myself is because I insist on stocks for their dependability, reliability, and predictability.
Most investors know that earnings growth helps to fuel dividend growth and one of the best metrics for us to use in the REIT sector is an earnings metric referred to as Adjusted Funds from Operations (or AFFO). As I explain in my book, The Intelligent REIT Investor Guide,
Although FFO as a measurement tool is more useful to REIT investors than net income under GAAP, a NAREIT white paper has correctly reminded us that FFO was never intended to be used as a measure of the cash generated by a REIT, nor of its dividend-paying capacity.
But AFFO is a reasonable, albeit imprecise, measure of a REIT's operating performance; it's a fairly effective tool to measure free cash generation and the ability to pay dividends.
The following is an oversimplified, but perhaps useful, way of looking at this methodology.
iREIT
AFFO is intended to measure current and recurring cash flows and is designed to be a closer proxy for actual normalized cash flows per share.
With that being said, you need to know that AFFO is not sanctioned by the SEC, therefore, it isn't always consistently reported. Plus, not all analysts view it the same, so some make their own adjustments to it.
That said, AFFO disclosure is very helpful to determine a company's high-level estimate of normalized cash flow per share.
We use AFFO when determining a REIT's payout ratio and of course most blue chips maintain a lower distribution as a risk mitigation tool to protect against a dividend cut.
As I point out in my book,
[T]h ere is no objective or commonly accepted definition of a "blue-chip REIT." You won't find it in Merriam-Webster's Dictionary no matter how hard you look, though I think the explanation I've compiled here should suffice.
I added that blue-chip REITs have certain qualities that set them apart, such as:
- Outstanding proven management that's familiar with the demands of real estate ownership and operation, and the quirks of public markets
- A track record of effective deployment of available capital to create shareholder value
- Balance sheet strength and flexibility
- Conservative and intelligent dividend policy
- Good corporate governance
- Meaningful insider stock ownership
At iREIT on Alpha, we score each equity REIT using our own quality scoring metrics and over the past 30 days many of these so-called blue chips have soared, pushing shares above our buy below targets.
As you can see below, Realty Income ( O ), Mid-America ( MAA ), Public Storage ( PSA ), and Camden Property ( CPT ) are moving into their premium valuation ranges:
We consider all four of these REITs well-positioned as they maintain healthy balance sheets, modest payout ratios, and strong earning potential. If you don't own these already, I recommend waiting on a pullback.
Nonetheless, we do have a few other blue-chip REITs that are worth exploring - and in this article I will highlight three such REITs that could provide you with meaningful upside. Keep in mind, I will examine each REIT based on both quality and value, recognizing that this is the most intelligent way to become a REIT investor.
Prologis Inc. ( PLD )
PLD is an Industrial REIT that was founded in 1983 and owns over 1 billion square feet of space on four continents (19 countries). On July 13th the company announced it was merging with Duke Realty ( DRE ) in w deal in a $26 billion all-stock transaction.
PLD noted it plans to hold about 94% of Duke's assets and will divest assets in one key market. Overall, PLD management believes the deal will result in about $310-$370 million of accretive cost savings from an administrative and operating leverage standpoint right away, and $375-$400 million in annual earnings and value creation over the longer term.
In year one, PLD expects to see $0.25 per share in FFO accretion, with AFFO coming out neutral.
The deal adds 1,228 acres to PLD's land bank and 165 million square feet of industrial assets. Duke's buildings have a 98.4% occupancy ratio, so the move will provide reliable cash flows from the start. The merger also provides Prologis with nice exposure to markets in the Southeast, the New Jersey coast, and Southern California.
One common thread that we find we most all of these blue chips is that they are the dominant player in their sector. With the Duke deal, PLD will become much larger and this will enhance the overall portfolio diversification.
In Q2-22 PLD's core FFO was $1.11 per share, slightly ahead of the forecast and retention was 79%, driving occupancy higher by 30 basis points over the quarter to 97.7%. This led to net effective same-store net operating income growth of 7.6% and cash same-store of 8.2%.
PLD began Q2-22 with $1.7 billion in new development projects, bringing the year-to-date starts to $2.7 billion.
The A-rated REIT ended the quarter with $5.2 billion of liquidity. The company increased its full year earnings guidance to $5.14 to $5.18 per share, including promotes and $4.54 to $4.58 per share excluding promotes, representing 11.5% growth from 2021.
Although PLD shares have increased by 13.5% in the past 30 days, we still find the company attractive, trading 8.55 below our buy target. Although PLD does have excellent peers in the sector, the company is clearly the dominant player and enjoys superior cost of capital advantages.
The forward-looking growth estimate (based on AFFO) of 13% in 2023 is also extremely attractive. Given the current valuation of 28x (P/FFO) and dividend yield of 2.3% (well-covered) we model PLD to return ~15% to 20% over the next 12 months.
Not the bargain when we wrote on the company last July (around $120/share), yet still plenty of pricing power and of course dividend growth.
Digital Realty ( DLR )
DLR is a data center REIT with a market cap of $37.1 billion and over 4,000 global customers and over 290 data centers across the globe. The company is the largest global provider of cloud and carrier-neutral data center and interconnection solutions.
DLR has an unmatched global operating footprint along with a strong development pipeline that continues to expand.
According to Precedence Research, they estimate that the cloud computing market size will grow to roughly $1.6 trillion by 2030, growing at a CAGR of 17.4% from 2022 to 2030. That is an enormous market for cloud providers, but also the often-forgotten segment of data center providers.
DLR's competitive advantages include its scale and cost of capital advantages.
DLR has a tremendous scale advantage with 291 Data Centers across 50 metro areas. Around 58% of its business is in North America and the balance is spread across EMEA (27%), APAC (10%), and Latin America (5%).
DLR has maintained healthy and prudent financial management with best-in-class balance sheet metrics including Net Debt/Adjusted EBITDA of 5.9x and Fixed Charge Coverage of 5.7x. The company has just 25% debt to equity and solid ratings from Moody's (Baa2), Fitch (BBB), and S&P (BBB).
DLR remains focused on its financial strategy of maximizing the menu of available capital options while minimizing the related cost of liabilities. The weighted average debt maturity is nearly six years, and the weighted average coupon is 2.2%.
In addition, nearly 90% of debt is fixed rate and 99% of debt is unsecured, providing the greatest flexibility for capital recycling. As you can see below, analyst forecast DLR's FFO/sh to grow by 4% in 2022 and 7% in 2023:
In terms of valuation, we find this blue-chip REIT to be attractively priced, around 15% below our buy below target. Shares are trading at $131.42 with a P/FFO of 19.6x and a dividend yield of 3.7%.
Once again, DLR is the type of consolidator that we want to own, and while the dividend yield is not as exciting as other high yield REITs, we see strong upside with an annualized total return forecast of 20%.
Federal Realty ( FRT )
The last blue-chip on my list is Federal Realty, a shopping center REIT that owns 104 open-air properties, all located in one of 9 high-barrier, first-ring suburban markets.
All of these locations are drivable with public transit access, and the company has 3,100 commercial tenants leasing 25 million square feet of space on 2,000 acres of land, as well as the new trend of 3,400 residential units, a segment the company is expanding.
FRT owns assets in retail, residential, office, and hotel properties, and out of its portfolio, 35% are currently mixed-use, and 75% of all centers have a grocery component, and 25% are grocery-anchored. These are some superb stats, and it only gets better from there.
FRT also has maintains a "fortress" balance sheet with "A" Bond Ratings from Moody's (A3 Stable), S&P (A- Stable), and Fitch (A- Stable) with over $1.3B in available liquidity and undrawn credit. The company is also in the process of disposing of $150M of non-core assets at a ~5% cap rate.
FRT expects to be back to pre-COVID leverage levels by the end of 2023, and already has a fixed charge coverage of over 4X, which is above the company's own guidance and targets.
Over 90% of the company's debt is at fixed rate, and only minor amounts mature before 2024, making the company extremely well-prepared for eventual downturns and issues here.
FRT recorded a Q2-22 28% YoY increase in FFO, and a 14.5% comparable POI growth. Like its peers, nothing is showing us that leasing activity or interest is declining, only increasing.
FRT recorded continued record leasing leaves, with 50% more comparable leases than any average 1st quarter in the past 10 years. FRT also has over $800M worth of both mixed-use and other asset redevelopments, that's set to be delivered in the next 3 years or so. As viewed below, analysts are forecasting FFO/sh to grow by 9% in 2022 and 5% in 2023:
In terms of valuation, you can see (above) that FRT shares have begun to move back up over the last 30 days (+13%) but in our view, there's more room to run. Shares are now trading at $11.68 with a P/FFO of 19.1x and dividend yield of 3.9%. We forecast shares could return ~20% over the next 12 months.
Quality Matters
As I said earlier, blue chip companies have solid business models and impressive track records including growing dividends, conservative payout ratios, disciplined management.
The reason that investors want to own blue-chip stocks in this environment is because they tend to outperform during recessions and market volatility. Over the years, as long as I have been writing on Seeking Alpha, I have continued to voice my concern for sucker yields, and I will continue to do so.
We're now starting to see the divergence (high yield junk vs high quality dividend growth) and I encourage all readers to remain disciplined and avoid chasing yield: the cream always rises to the top.
For further details see:
3 Blue-Chip REITs On Sale